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Over the past 5 years the importance of the “High Growth Business” and how this relatively small group of businesses disproportionally impa...

Friday, 6 June 2014

How Sub Contractors Can Steal Your Profit

Its very common these days to sub contract some services on the grounds that it frees your time and enables you concentrate on developing your business. Whilst this is true and often very helpful, one should always "do the maths" to see if the extra time and convenience is not outweighed by the transfer of your profits to the subcontractor.

Here are three examples from three different businesses that illustrate this issue nicely.

Case 1 A business outsources some key components of a contract resulting in the subcontractor billing an amount equal to 50% of the subcontracting company's total monthly turnover for three consecutive months. The results for the period were, turnover up by 50% but profit down by 98%.

Case 2 A services business employed a team of subcontractors to undertake some high level consultancy. This was a 6 month contract which made a respectable £282,000 profit. Employing equivalent staff for the same contract, however, would have delivered a profit of £452,000

Case 3 A construction business hired a subcontractor with specialist machinery at £1900 per day. Purchasing the same machinery under finance would cost £1300 per month.

In my experience in dealing with high growth companies these situations are by no means exceptional and illustrate nicely the risks of subcontracting without "doing the maths". Why do these situations arise? There seems to be two main answers firstly the subcontracting business doesn't understand the financial implications of its decisions. Secondly and perhaps more surprising is the worry about the financial commitment of taking on extra people.

Understanding the financial situation is of course "doing the maths". Often this is no more complicated that calculating the cost of subcontracting against the cost of doing it yourself. The problem for many is they don't have any current financial information on their business. Consequently decisions are driven by the need to find resources without looking at the longer term implications. "Doing the maths" should indicate when it becomes more profitable to do it yourself. This cross over point is often sooner than one might think; for example in case 3 if the business could use that subcontracted machinery for as little as three days per month it becomes cheaper to employ a person and buy (on finance) the machinery rather than subcontract.

The inertia around taking on staff is an altogether more significant. A lot of this is to do with peoples expectations of the future and for the past few years its been rather cautious if not pessimistic. Despite clear signs that we are emerging from the economic doldrums many business owners hold very conservative views about the future. Consequently they are very reluctant to take on more staff. Part of this is because they don't have a clear view of the future trends and demand and what that means for their business.

Those business owners who have processes and systems in place to peer into the fog of the future will gain extra advantage over their competition because they will able to access information which will give the insight into what is going to happen in the future and have more confidence in the benefits of recruiting additional staff.

For the rest the convenience of and inertia of moving employing subcontractors will provide them with the illusion of additional flexibility whilst exporting the potential profit of additional work from themselves to their sub contractors.